In this article I will discuss about small cap Equity funds and its major concepts, which will give you fair idea for making decision on investment in small cap funds.
What is Small Cap Funds?
Based on its market capitalization a company is classified as small cap or mid cap or large cap.
Small cap funds are shares of those small cap companies which have small market capitalization.
Market capitalization means the aggregate of market value of a company shares.
Normally a company with less than Rs. 8000 crore market capitalization is considered as small cap funds.
SEBI has notified how to define a company in large cap, mid cap or small cap vide its circular no. SEBI/HO/IMD/DF3/CIR/P/2017/114.
According to SEBI, average of market caps from all exchanges (BSE, NSE) of previous 6 months of a company are taken to calculate its final market capitalization.
Based on this calculation, list of all companies are prepared with their market capitalization.
The top 100 companies with highest market capitalization are considered as large cap companies.
Companies from 100 to 250 in the list are considered as mid cap companies.
Companies from 251st rank are considered as small cap funds.
Why a company is classified as small cap?
SEBI has classified into three categories to ensure uniformity in investment criteria for equity mutual fund schemes.
Who should invest in small cap funds?
When a company is young and willing to expand, in this time they are more volatile to face a loss.
Furthermore due to its aggressive nature it can enlarge its profit, due to this nature individual investors are interested in small cap funds rather than an institutional investors who prefer in investing in a large cap stable fund.
Investor who has an ability to take a high risk is suitable to invest in this small cap fund.
It is usually advisable to create a portfolio such that a small percentage will be allocated to small cap fund due to its risky nature, and investor should also not remove small cap fund from their portfolio due to its ability to generate a high return.
Patient investors should deal with this type of investment.
What to consider before investing in small cap funds?
Investors should consider the following while dealing with such kind of funds.
RISK– During recession small cap funds suffer the most as it is not well established and they also tend to move out of the market.
It is also a suitable option for the investors who are looking for an aggressive growth.
Long term Investment Horizon– A long term investment horizon is needed for investing in this class of funds as it declines when market goes down and due to this a long term investment perspective is needed to give a good amount of return.
Return– Small cap fund is considered best for an aggressive and speedy return.
During last few years this class of shares are considers best for giving a higher return compared with other class of funds.
Cost– Expense ratio is the ratio is also an important factor as a lower expense ratio yields higher return & vice versa, while choosing small cap funds look towards exp ratio.
Financial goals – This cap fund is best for the investors who are having a long term financial goals as these investment benefits during the long term period as a young enterprise takes time to grow, & to give higher returns compared to bench mark & other funds.
Capital gain tax– Capital gain tax will be applied on every unit of fund sold at price above cost price. Capital gain tax is divided into short term & long term capital gain. Capital gain tax is chargeable less on long term capital gain hence investors gain a lot on long term investment by saving tax & earning more return.